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3 Baby Steps To Building Your First Profitable, Globally-Diversified Portfolio

February 7, 2012

So you’ve made it through the account opening process and you’re ready to invest. But the first dollar is always the hardest. Here’s one way to ease into the world of investing.

Author : Nick Tay

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You want your money to work for you.

You’ve read the literature, you’ve spoken to your friends, and you’ve a healthy skepticism for financial salesmen in disguise. After all, there’s no shortage of horror stories on the internet about unscrupulous advisors who sell products with the fattest commission at the expense of their client’s financial health. (This isn’t to say all advisors are unscrupulous, just that unscrupulous ones get more attention.) So you’ve pretty much decided that the one person with your best financial interests at heart is…you.

In other words, you’re taking those first steps towards being an independent investor.

Assuming you’re a novice and you worry about getting washed up, what then?

Baby Steps

My proposal to you is best captured in a Robert Kiyosaki quote:

Remember to dream big, think long-term, underachieve on a daily basis, and take baby steps. That is the key to long-term success.- Robert Kiyosaki

While he is a vocal critic of the US mutual fund industry, Kiyosaki makes a very good point that the path to success is often measured in tiny baby steps.

Learning to invest successfully (i.e. profitably) is very much accomplished in tiny baby steps. When you’re starting out, many investors flock to the easiest answer – pick a fund, throw S$1000 in, and hope, sometimes fervently. While some have made money using the “pay-and-pray” approach, we prefer something a little more systematic, especially when the investor is just getting started. And while these baby steps won’t deliver instant returns, they’ll at least point you in the right direction, and give you an encouraging little push.

Baby Step #1: Mentally Prepare Yourself For Loss…And Gain
Investing is the art of putting a price tag on uncertainty. If anyone tells you they have a foolproof method of investing whereby prices conquer gravity for indefinite periods of time, then prudence demands you run away. The reality is summed up by a classic quote from Peter Lynch, the investing legend whose fund returned 2700% from 1977 to 1990.

In this business if you're good, you're right six times out of ten. You're never going to be right nine times out of ten.– Peter Lynch

The reality is even the best fund managers, like Peter Lynch, execute strategies that work roughly two thirds of the time. Let’s assume you hold a fund with a decent strategy for 10 years. Over those 10 years, you’ll be looking at negative yearly returns four times out of ten. The question then becomes, “are you prepared to spend roughly 40% of your holding period looking at a negative number?”

If you can answer, “yes” with a straight face. Then you’ve taken a baby step ahead of those who haven’t.

(Hint: it helps if you remember the cardinal rule of investing - only invest money you can afford to lose.)

Baby Step #2: Diversify Correctly
We preach the virtues of diversification. Not the sort that requires you to hold 400+ funds in your portfolio, but the sort that requires you to correctly invest in two or more weakly-correlated assets.

What are weakly-correlated assets? A simple, usable explanation: two assets are weakly-correlated if their prices tend to rise and fall independently. Having two weakly-correlated assets is the airplane equivalent of having backup engines – both help keep the airplane aloft, and if one engine crashes, the rest of the plane won’t go crashing down with it.

In investing terms, two weakly-correlated assets are equities and bonds. When equity markets crash, bond markets stay afloat, and vice versa. So in a portfolio with equity and bonds, when equities experience a severe correction, bonds will hold the portfolio steady.

Bottom line: a correctly diversified portfolio should consist of both equity and bond funds.

(Hint: A more complete discussion can be found in a previous article on portfolio construction, link)

Baby Step #3: Baby Steps, Not All At Once
We recommend investing via dollar-cost averaging, which is essentially investing in small amounts. For instance, if you decided to invest S$2000 into a fund, we prefer you make the initial investment of S$1000, and slowly invest the remainder in S$200 chunks.

Sure, if you time it right, you could make more money if you threw a bathtub of cash into the market, but this goes back to the point of baby step #1: the best strategies will be wrong 4 out of 10 times. Truth is you can’t time the market, or predict the ‘best time’ to get in. So the better way to take a position is to do in baby steps. And here’s where the Regular Savings Plan, RSP for short, comes in.

A non-RSP fund will require a minimum initial investment of around S$1000. A RSP fund allows you to invest take S$100 positions on a monthly basis. This lets you get in slowly, in little baby steps, and not all at once.

Ok, So Now What
Like we said earlier, three baby steps are not going to turn you into Singapore’s next big investment genius. But they will point you in the right direction, and steer you away from any huge blunders that novice investors occasionally make. With these three steps, you’ve got enough knowledge to start a small portfolio, with a regular savings plan.

Nick Tay tweets randomly on Twitter, connects with people on Facebook or Google+, and loves all things investing, social media and Youtube. If you have feedback, you can email, or leave a post on the forum. I promise to read all feedback, and will make every effort to respond where possible. If you know of anyone who can benefit from this article, do a favour and share it with them– but only if you think it’s worth sharing!

Nick Tay of the iFAST Content Team is part of iFAST Financial Pte Ltd.

iFAST and/or its licensed financial adviser representatives may own or have positions in the funds of any of the asset management firms or fund houses mentioned or referred to in the article, or any unit trusts or Singapore Government Securities bonds related thereto, and may from time to time add or dispose of, or may be materially interested in any such unit trusts or Singapore Government Securities bonds. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund's prospectus. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.